French Economy Needs Competitive Edge to Grow

Cut government debt, deficits at pace that balances support for growth, reassures financial markets

Resilient banks need more steady funding source

Low growth and a loss of competitiveness that predates the ongoing crisis in Europe are clouding France’s outlook for recovery.

As elsewhere in Europe, the hints of recovery in 2010 and 2011 gave way to near stagnation in 2012. Unemployment rose to over 10.7 percent in October, with youth unemployment an alarming 25.5 percent.

The International Monetary Fund’s latest annual check-up of the French economy said the country’s economy grew 0.2 percent in 2012. The IMF predicts the economy will grow 0.4 percent in 2013 and that unemployment will rise further.

Next year’s projection takes into account the weak environment in Europe generally. This includes the impact of continued fiscal consolidation, which is the reduction of government deficits.

The IMF expects the crisis in Europe will have lingering effects, which means growth won’t begin to pick up as quickly as the government expects.

“France has become a less open economy than its European peers over the last decade, which limits the economy’s ability to rebound in the short term, and will constrain growth over the next few years,” said Edward Gardner, an assistant director in the IMF’s European Department and head of the mission that conducted the assessment.

Reforms to boost growth

To get the economy growing again, France needs to regain competitiveness relative to its main trading partners, according to the IMF. The country’s competitiveness gap is now the main challenge for economic stability, growth and job creation. The loss of competitiveness predates the crisis, but risks becoming even more severe if the French economy does not adapt along with its major trading partners in Europe: Germany, Italy, and Spain.

The government needs to reduce its debt and deficits at a pace that balances support for growth while giving financial markets more confidence in the country’s ability to tackle public debt.

If economic activity in the euro area and in France continues to weaken, policymakers should consider a revision in the speed of fiscal consolidation, in coordination with European partners, to provide more support to the recovery, the IMF said.

The choice of policies to reduce fiscal deficits is also critical for improving competitiveness. High rates of taxation in France—already among the highest in Europe—create an additional competitive disadvantage. For this reason, priority should go to containing and rationalizing spending at all levels of the public sector, the IMF said. This includes constraining local government spending, respecting health spending limits, and adapting the retirement age in a timely manner to preserve the pension system’s financial balance.

The IMF said the key to growth and employment lies in reforming the structures and institutions that affect the way the country’s economy functions. Such structural reforms should include policies to make the labor market more responsive to the needs of enterprises and at the same time more inclusive for employees, as well as policies to increase competition in product markets.

If enterprises had greater leeway to adjust working conditions in response to market conditions for their goods, they would face stronger incentives to invest and hire in normal times. The challenge for the government is how to make the economy more efficient while preserving the benefits of France’s inclusive social model.

Financial sector

French banks have proven to be resilient in the face of shocks, but the crisis has exposed the risks posed by their size and complexity. The IMF noted that French banks had moved swiftly to strengthen their solvency ratios and funding structures in the wake of the crisis, largely by reducing their cross border operations in non-core activities, such as trading and investment banking. At the same time, banks remain heavily reliant on wholesale funding, which could be a source of vulnerability in the event of another severe liquidity or euro area confidence shock.

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